VAR Settlement under Section II of the ISO-NE Tariff (Schedule 2 - VARs) VAR WG – 06/16/05 v3

1. VAR Settlementunder Section II of the ISO-NE Tariff(Schedule 2 - VARs)VAR WG – 06/16/05 v3

2. Schedule 2 - Reactive Supply and Voltage Control from Generation Sources Service • Schedule 2 sets forth how: • generators providing this service will be compensated; and • how the costs of providing this service will be paid. • In order to maintain transmission voltages on the New England Transmission System within acceptable limits, generation facilities may be directed from time to time by the System Operator to operate to produce or absorb reactive power. • To the extent that they are directed to produce (or absorb) reactive power, generation facilities are compensated for certain costs related to VAR control.

3. What Costs are Compensated for under Schedule 2? • Schedule 2 compensates for four (4) types of costs related to VAR control: • Capacity Cost (CC) • Lost Opportunity Cost (LOC) • Cost of Energy Consumed (SCL) • Cost of Energy Produced (PC)

4. Capacity Cost (CC) • Is a payment that compensates generators for the equipment needed to deliver VARs to the system. • CC VAR Rate - annual formula rate calculation, established at beginning of yr., in effect for calendar yr. • CC VAR Rate = Base VAR Rate * Factor • Base VAR Rate = $1.05 / kVAR-yr • Factor equals 1 or less than 1, if there is “excess” generator VAR capability. • Monthly compensation • based only on the generator’s lagging capability. • calculated at a generator’s NX-12D Lagging VAR value * (CC VAR Rate / 12).

5. Capacity Cost (CC) Requirements • Be in the ISO-NE Market System. • Have an NX-12D form and an NX-9B database on file at ISO-NE. • NX-12D form - Generator Reactive Data (OP14) • NX-9B database - ISO New England Transmission Facility Rating, Characteristic, and Operational Data Implementation Form – Transformer - Fixed/GSU/TCUL (OP16) • Conduct a VAR demonstration test. • Requirements established under the Reactive Supply and Voltage Control from Generation Sources Service Business Procedure.

6. Lost Opportunity Cost (LOC) • Is a payment that compensates generators if ISO, a Local Control Center or a “dispatch center” reduces the output of an on-line hydro, pumped storage or thermal generating unit for the purpose of VAR control. • LOC: • is a variable compensation mechanism. • compensation equals (the energy that the generator would have sold in an hour had it not been backed down for VAR control) * (LMP in that hour).

7. Cost of Energy Consumed (SCL) • Is a payment that compensates hydro and pumped storage generators if ISO, a Local Control Center or a “dispatch center” motors an off-line hydro or pumped storage generating unit for the purpose of VAR control. • SCL: • is a variable compensation mechanism • compensation equals (the energy consumed in an hour) * (‘LMP’ or ‘the energy rate under a retail power agreement’ in that hour). • Generator must submit an invoice for SCL costs.

8. Cost of Energy Consumed (SCL) cont. • SCL also applies to Synchronous Condensers (SC) and Static Controlled VAR Regulators (SCV). • SCL is set to zero ($0); and • The cost of energy for VAR control by the Chester SCV will be treated as losses on the New England Transmission System. • “Placeholder” that can be revisited on an as-needed basis (e.g., upon the addition of a new SC or SCV within the New England Control Area).

9. Cost of Energy Produced (PC) • Is a payment that compensates a hydro, pumped storage or thermal generating unit if ISO, a Local Control Center or a “dispatch center” brings the unit on line (and the unit produces real power) for the purpose of VAR control. • PC: • is a variable compensation mechanism • compensation equals the uneconomic energy (based on the difference between the generator’s offer price and LMP) that the generator sold in an hour due to its being brought on line for VAR control.

10. Who Pays for VAR Expenses? • The hourly VAR costs are allocated on a pro rata basis to Transmission Customers with: • Monthly Regional Network Load (HL), and/or • Through and Out Service Reservations (RC). • The hourly VAR costs equals for each hour: • (CC + LOC + SCL + PC) * (HLn +RCn) / (Sum RC+HL); where • the monthly CC cost is converted to an hourly cost; and • Monthly Regional Network Load is used as a value for each hour. • Note that this is a regionalized distribution of costs.

11. VAR Costs January 2004 through April 2005* *(January through April 2005 preliminary values) • Total monthly VAR costs for this 16-month period have averaged roughly $7.9 million/month or roughly $134 million for the period. • CC costs run roughly $1.04 million/month. • LOC + SCL + PC costs have ranged: • from a low of $0.6 million/month (02/04) • to a high of $15.4 million/month (04/05)

12. Impact on Regional Network Load • For the period between January 2004 and April 2005*, Regional Network Load paid roughly $134 million under Schedule 2. * (January through April 2005 preliminary values) • BECO Regional Network Load paid $22.2 million. • Bangor Regional Network Load paid $1.7 million. • ComElec Regional Network Load paid $4.8 million. • CMP Regional Network Load paid $9.4 million. • NEP Regional Network Load paid $37.9 million. • NU Regional Network Load paid $47.8 million. • UI Regional Network Load paid $4.6 million. • Velco Regional Network Load paid $5.5 million.

13. - Current VAR Cost Allocation Questions - Room for Improvement? • Are some of the current generator VAR costs sub-regional in nature, such that certain elements of these costs should be charged to the sub-region of New England in which the generator is located? • For example, should: • CC costs be charged regionally, and • PC, LOC and SCL charged sub-regionally? • Schedule 2 provides a price signal but does it provide the appropriate incentives?

14. - Current VAR Cost Allocation Questions -Room for Improvement? cont. • Recognizing the need to compensate generators for their VAR costs, is it appropriate to allocate all VAR costs to entities with Network Load or T/Out Service Reservations? • Should VAR costs be allocated (in part or in total) to entities who have the ability to pursue solutions to VAR problems in the region? • Do entities with Network Load or T/Out Service Reservations have this ability to “realistically” pursue such solutions? • Should a portion of the VAR costs be charged to entities other than those with Network Load or T/Out Service Reservations to encourage resolution of VAR problems in the region? • Other suggestions?

15. Upcoming Changes that could Impact VAR Settlement • VAR demonstration test. • Schedule 2 and the Reactive Supply and Voltage Control from Generation Sources Service Business Procedure state that the VAR demonstration test will include multi-point (MW output) tests of both lagging and leading VAR capability in 2008. • NERC or FERC requirements: • FERC NOPR on VARs (based on FERC Staff paper on Reactive Power Supply and Consumption) • NERC Standards (4th Qtr 2005) • Voltage Support and Reactive Power (static/dynamic reactive power resources on the transmission system ensuring system performance) • Verification of Reactive Power Capability (generators) • VAR WG recommendations

16. Questions / Additional Discussion